Memorandum submitted by CDC Capital Partners
The recently published CDC Group plc Annual Report 2001 and Financial Report 2001, as accompanying documents provide significant detail of last year's activities and should be read in conjunction with this additional submission. Appendix A provides some background Government statements on CDC.
The objectives are:
to invest in long term sustainable businesses in developing countries, especially poorer countries;
to mobilise private finance into developing countries, by offering investors acceptable risk-adjusted returns; and
to implement social, environmental and ethical best practice in the conduct of its investment activities.
Chairman's Statement: CDC 2001 Annual Review:
"Success for CDC is to create significant, sustainable, profitable enterprises in the poorest countries of the world and, in due course, to show financial returns commensurate with the risks we take. "
These underpin all CDC's activities, and are expressed in the Investment Policy, the key elements of which are summarised in the Government's White Paper on International Development, and in the Government's paper on its approach to Public Private Partnerships (see Appendix A).
Decades of aid and subsidy, while offering some short-term alleviation, have not resulted in significant sustainable economic development, so the UK Government is calling for substantial investment of private capital alongside government-funded programmes. The aim behind CDC becoming a public-private partnership is that CDC will not only manage and invest public sector funds, but also raise and manage private capital as well. Under any circumstances, this is a difficult challenge as private capital is not naturally attracted to invest in poorer countries where the risk/reward relationship is not perceived favourably. CDC's role in poverty alleviation as a financial investor can be enlarged by demonstrating that there are profitable investment opportunities in developing countries and thereby mobilising additional private sector funding. Hence, by supporting viable businesses with equity investment, we aim to earn adequate risk-adjusted returns over the investment cycle, which should enable CDC to mobilise additional third party capital.
Dr. Mohamed Ibrahim, Founder and Chairman of MSI Cellular, a pioneering mobile telephone company operating throughout Africa, in which CDC is an equity partner, says:
"CDC was our first investor and their presence has helped MSI attract both other developmental finance and private sector money from the likes of Citigroup and AIG. "
For CDC to compete effectively for private sector funding, we need to make a financial return which reflects the risks which we take, and is in line with market requirements. For example, recently, private equity funds operating in Latin America have raised funds by offering investors returns potentially in excess of 30 per cent. The 2001 prospectus for a US$350 million fund for African infrastructure targeted a return of 25 per cent. Unlike other Funds, we cannot switch our investments into different markets when the poorer countries become more difficult environments in which to operate and, therefore, are subject to higher risk.
This requirement for an enhanced return accompanied a change which CDC commenced earlier in the 1990s, from being a debt provider to a private equity partner, driven by the acute lack of equity in the countries where we operate. In 1990, the portfolio was split 20 per cent in equity, 80 per cent in loans. By 2001, as existing loans have been repaid and equity investments made, the split is 53 per cent equity and 47 per cent loans.
In 2001, £230 million was generated as cash mainly from the repayment of existing debt and is available for investment as equity. CDC's shift from debt to equity is an explicit acknowledgement that the provision of equity (risk capital) is much more at the heart of the economic development process. Whereas loans to companies are repayable against a defined redemption date, equity capital is permanent and foundational to the balance sheet. Debt finance is more readily available today in CDC's markets than in previous years, through local and international commercial banks and development banks. Equity is in short supply, hence CDC's role is to fill the "equity gap" in local businesses seeking to establish or expand.
Provision of capital as equity is a much higher risk activity than making loans; accordingly CDC is today far more deeply engaged in the development finance process than during its years as a lender. In providing equity, CDC not only provides core capital to companies, but also enables these companies to gain more easily access to other forms of debt finance, leveraged off the equity base.
Investment in a company's equity capital also gives greater opportunity to influence that company's operational behaviour as an owner/shareholder than as a lender. Consistent with CDC's mission to implement social, environmental and ethical best practice, CDC is increasingly able to encourage management of investee companies, often through our position on the company's Board, to adopt best practice. This is a significant development contributionthe improvement in company behaviourin addition to purely providing capital.
CDC AND DEVELOPMENT
CDC has a clearly defined task within DFID's overall poverty reduction strategy. We typically invest £200 million each year, which represents approximately 6 per cent of DFID's estimated 2001-02 development budget. Our objective of mobilising private sector capital is an important factor in allowing CDC to do more than its own balance sheet permits. It also must be recognised that the UK's resources committed to development far outweigh the relatively small proportion of the effort delivered via CDC.
Chief Executive's Review, CDC:
"It is important to reaffirm the part CDC plays among many other UK-sponsored programmes in seeking to fulfil the challenging role of halving world poverty by 2015. In this task, CDC is not an `aid agency' or a `development bank' but it plays an important art in harnessing and directing capital flows towards the private sector in the world's poorer countries. "
The chart below shows the spectrum of development, which spans immediate and urgent provision of humanitarian aid and disaster relief, through to long-term investments in infrastructure and private enterprises. The chart also shows the type of finance which is typically required for each type of development, from grant funding, via loans (sometimes at subsidised rates), through to equity investment. CDC plays a role in financing private sector enterprises at the long-term private sector end of this development spectrum.
Sustainable economic development requires private sector business to anchor the process, as permanent, locally established enterprises create wealth and provide employment.
"Large firms contribute decisively to development. In competitive conditions, they are able to take knowledge from more advanced economies and adapt it to their own. "
"One of the main poverty-reducing impacts of foreign direct investment is job creation. "
Paths out of Poverty; IFC 2000
CDC contributes towards development by investing in sustainable and profitable businesses, which in turn should cause economic and social improvement through providing employment, training, tax revenues, utilising supply chains, encouraging the application of superior technology, and often generating foreign exchange earnings.
One accepted measure of economic development is employment. We estimate that companies in which CDC currently invests employ in total over 190,000 people (see Appendix D). It is likely that the number of people directly and indirectly supported by these employees is several times as high.
CDC first invested in Daksh eServices Pvt Ltd, an Indian business process outsourcing company, in March 2000. It's now employing 2,000 and has plans to expand its facilities to accommodate 1,000 more people, financed with a new equity injection from CDC among others.
The establishment of significant, profitable enterprises can help to alleviate the "brain drain", an increasingly worrying problem for developing countries, in two main ways:
by providing attractive employment opportunities for professionals; and
by improving the quality of living in the countries, for example with better retail facilities and telecommunications.
"Driven by considerable disparity in working conditions between Africa and countries of emigration, the brain drain cripples Africa's economies and diminished human resources. "
"Africa lost 60,000 professionals (doctors, university lecturers, engineers etc) between 1985 and 1990, and has been losing an average of 20,000 annually ever since. "
World Market Research Centre 2002
CDC'S INVESTMENT CYCLE
CDC operates as an investor in line with the established investment process and cycle of any fund manager.
The key activities in the investment cycle are:
identifying and appraising the potential investment;
negotiating and making the investment;
managing the investment to maximise its value; and
Each of these steps present particular challenges in the markets where CDC operates. In many countries, particularly the smaller economies, few suitable equity opportunities arise for CDC to invest. Our appraisal work can be hampered by, for example, lack of market data or absence of a track record for the company. Due diligence is often problematic. Negotiations need to structure our investment within the boundaries of the local legal system, which may not offer investors the protection normally expected.
IMF Finance and Development (December 2000):
"Although there is little agreement as yet on what constitutes sustainable development, there is agreement that, for projects to benefit host countries, they must, first, be profitable. "
CDC does not intend to "hold" investments indefinitely; we expect after an appropriate holding period (during which value is added) to look for a disinvestment opportunitynormally called the exit. Comment has recently been made about CDC "selling off" investments. This is a central feature of any equity investment manager and by identifying another responsible investor(s) to step into CDC's shoes, fresh capital becomes available for reinvestment. A successful exit is essential to recoup the initial investment and to generate the target rate of return.
Professor Jonathan Kydd (Non-executive Director, CDC Group plc), Imperial College of Science Technology and Medicine:
"CDC's model of contributing to building businesses through supplying risk capital, informed by country and sector expertise, and then exiting, is developmentally appropriate. This is a relay race, in which CDC runs at an early stage, and hands on the baton when another investor is willing to take over. Moreover, successful exits realise capital for reinvestment. CDC's recent agricultural exits should be seen in this context. "
In developed markets, private equity investors often exit by listing the company on a stock exchange. However, these are too illiquid and immature in many developing countries to present a viable exit option. Our most common exit route is a trade sale; selling our stake to a strategic buyer. This is not "selling off", but "selling on" to a more suitable owner in the next stage of the company's development.
Some recent examples include:
in 2001, we sold our controlling stake in Rwenzori Highlands Tea, Uganda, to Finlays, who already owned a minority in the company. Finlays is a global integrated tea company, with other plantations in Kenya, Bangladesh and Sri Lanka, who saw tea production in Uganda as a key element in its strategy. The existing management team continued in position under the new ownership, and Finlays envisaged that it would be "business as usual";
in the mid 1990s, CDC purchased controlling stakes in three significant African cement businesses, in Zambia, Malawi and Tanzania, as part of the respective Government's privatisation programme. CDC formed these into a single, more efficient and competitive regional cement company. In 2000, this operation was sold to Blue Circle and Lafarge who already have cement interests in the region, and who are in a position to develop the businesses further.
INVESTING IN LONG-TERM SUSTAINABLE BUSINESSES
Over the three years 1999 to 2001, CDC has made first-time investments in 60 companies, which spanned 36 countries. We have also made further investments in another 200 companies in which CDC had previously invested. In total, our investment in these three years was £671 million. Our portfolio of investments is currently valued at £816 million, of which 80 per cent of investments made over the past five years have been in poor countries (World Bank definition).
Appendix C describes some of CDC's recent investments, and Appendix D lists the total equity portfolio.
CDC: MOBILISING ADDITIONAL FINANCE INTO DEVELOPING COUNTRIES
Consistent with one of its objectives, CDC has been successful in attracting significant amounts of third party investment:
our investments from January 1997 to date (approximately US$1.3 billion) have assisted the mobilisation of US$6.3 billion from third parties, including other shareholders, international and local banks, and development finance institutions;
between 1994 and 2000, CDC established 14 country/regional funds, targeting investments in small- and medium-sized enterprises (SME Funds). CDC has committed over US$50 million into these funds, and mobilised over US$110 million from third parties;
in 2001, CDC created Aureos, a joint venture fund management company with Norfund to manage and expand the above SME Funds. Norfund committed an additional $50 million finance for follow-on and new funds. Aureos plans to raise an additional US$150 million from new investors for three additional funds for Africa and one fund for Central America;
CDC established the Commonwealth Africa Fund (Comafin) and the South Asia Regional Fund (SARF) under the Commonwealth Private Investment Initiative, with a total commitment of approximately US$75 million from CDC and US$96 million from third parties;
in 2000, we established China Capital Partners, a joint venture with the CGNU Group, who matched CDC's US$50 million commitment to the fund.
In early 2002, we participated in a US$135 million investment in three power companies in Latin America from Entergy Corp. We invested US$ 70 million and arranged additional equity investment of US$32 million from the Scudder Latin American Power Fund II. We are in the process of raising US$50 million through a public bond issue in the Peruvian local capital market.
CDC: IMPLEMENTING SOCIAL, ENVIRONMENTAL AND ETHICAL BEST PRACTICE
A key tenet of the CDC Act 1999 was that CDC should continue its investment in line with social, environmental and ethical best practice.
We invest only in companies which agree to sign up to the set of principles shown on the following page. Some examples are also given where CDC's investment has made a difference to a company in line with each of the principles. Since shifting from the provision of loans to become an equity investor, CDC has a far deeper engagement with the companies in which it invests. This influence enables CDC, through active investment management, to encourage its investee company to improve its business behaviour.
CDC's Business Principles Unit assists local management to assess whether a company complies with our business principles before we invest, and to draw up a corrective action plan if needed. We continue to monitor each company's performance in these areas throughout the life of our investment, with a particular focus on high risk sectors. We believe the fact that these issues represent a cornerstone in our investment process differentiates us from most other private equity firms.
In 2001, we engaged the Ashridge Centre for Business and Society to carry out an independent review of our business principles process and their report is published on pages 14-15 of the CDC Group plc Financial Report 2001.
Ashridge Centre for Business and Society, March 2002:
"There is clear evidence [within CDC] that potential and existing investments are being assessed and managed with regard to health, safety, environmental and social performance. "
Many companies in which CDC invests have received external recognition for their strong social, environmental and ethical performance. Select examples include:
La Favorita, Ecuador
ISO 9002 Quality System, ISO 14001 Green Dove Award, ECO-OK Rainforest Alliance Approved and Better Bananas (Rainforest Alliance Certified)
Del Oro, Belize
Del Oro (Belize) Ltd: first company in Belize to be awarded ISO 14000 certification, in addition to ISO 9000
Fairtrade accreditation, which includes paying premium prices to outgrowersthe surplus funds are channelled into a fund for social/livelihood purposes
Mhlume Sugar, Swaziland
Four star NOSA rating (National Occupational Safety Association)
Kolombangara Forest Products, Solomon Islands
Only certified sustainable forestry business in Pacific region (Forestry Stewardship Council)
Engro Chemicals, Pakistan
Corporate Excellence Award by the Management Association of Pakistan on eight occasions. Has won the ENERCON awarda National Energy Management Award, presented to those demonstrating extraordinary achievement in implementing successful energy conservation programs
1 See www.cdcgroup.com. Back
2 Copy placed in the Library. Also available upon request from CDC Capital Partners. Back